The Power of Gold: The History of an Obsession

by Peter L. Bernstein

  As an example of the literary tone of the "Representation," here are the opening phrases of the substance of the document:

  I humbly represent, That a Pound Weight Troy of Gold, 11 Ounces fine, and 1 Ounce Allay, is cut into 44 Guineas and Half, and a Pound Weight of Silver, 11 Ounces, 2 Penny Weight fine, and 18 Penny Weight Allay, is cut into 62 Shillings; and according to this Rate, a Pound Weight of fine Gold is worth 15 Pounds Weight 6 Ounces, 17 Penny Weight and 5 Grains of fine Silver, reckoning a Guinea at 11. 1s. 6d. in Silver Money.47

  Newton then proceeds to carry out similar kinds of calculations for Spanish pistoles, French lewidors (Louis d'Or), and Dutch and Hungarian ducats, as well as examining the situation in Italy, Germany, Poland, Denmark, Sweden, China, and Japan. He confirms that the demand for silver for export "hath raised the Price of exportable Silver about 2d. or 3d. above that of Silver in Coin, and hath thereby created a Temptation to export or Melt down the Silver Coin, rather than give 2d. or 3d. more for foreign silver. "41

  Newton's argument ends up with the observation that "There seems nothing more requisite, than to take off about 10d. or 12d. from the Guinea, so that Gold may bear the same Proportion to the Silver Money in England which it ought to do by the Course of Trade and Exchange in Europe. 1149 On the basis of Newton's advice, the Treasury issued a proclamation on December 22, 1717, prohibiting anyone to pay or receive the gold guinea coins at a value different from precisely 21 shillings. The outcome was not the expected outcome. Newton had it wrong on two scores.

  First, as matters turned out, 21 shillings was still too high a value for the guinea: defying Newton's predictions, the imports of gold and exports of silver continued, even though at a reduced rate. The process persisted, in fact, for about thirty years, beyond 1717, by which time full-weight silver coins had disappeared from circulation.

  Second, Newton was confident that the laws of supply and demand would solve the matter so that the problem would simply go away with the passage of time. He was confident that the continued increase in the supply of gold would bring down the price of guineas as denominated by silver shillings. "If things be let alone," he wrote, "till silver money be a little scarcer, the gold will fall of it self.... And so the Question is, Whether Gold shall be lowered by the Government, or let alone `till it falls of it self, by the Want of Silver Money?""'

  That is not what occurred at all. Newton's forecast turned out to be wrong on a more fundamental level than merely expecting the laws of supply and demand to bring everything to rights. He was correct that in the end gold would have to decline in value relative to silver. But, like many economists since then, he went astray in assuming that the future would look like the past. Economics is evidently a lot more difficult than physics, even for a genius like Newton.

  The unexpected happened: the price of gold did not "fall of itself." In fact, it did not fall at all. Instead, the guinea held steady at 21 shillings, while silver coins began to exchange at more than face value. Gold still lost value relative to silver, but the price that moved to accomplish that shift was the price of silver, not the price of gold. Although the ultimate outcome was the same either way, the markets themselves, without any Acts or Orders-in-Council or Representations, had silently but decisively established gold in place of silver as the standard for the pound.

  As so often happens, the markets were way ahead of the officials. As late as 1730, John Conduitt, Newton's successor at the Mint, was still reciting the old story that "Gold is only looked on as a commodity, and so should rise or fall as occasion requires. An ounce of fine silver is, and always has been, and ought to be, the standing and invariable measure between nation and nation"51 (italics added). Reality, however, had moved strongly and decisively in the opposite direction since 1717. For more than two hundred years, the price of gold in Britain would remain set at _3 17s 10% d while the price of silver would succumb to violent fluctuations.* Until the official devaluation of the pound in the terrible crisis of 1931, £3 17s 10%d became a kind of magic and worshipful combination of numbers that governed English monetary policy.

  This unanticipated outcome was a direct reflection of the increasing popularity of the guinea. The guinea's consistent weight and fineness made such a vivid contrast with the rotten state of the silver coinage up to the Great Recoinage that people preferred to accept the guinea wherever possible. Bankers held it as reserves, tax collectors welcomed it in order to avoid the arguments about what a worn silver piece might be worth, and economic activity in England at that time had developed to a point where a large-denomination coin such as the guinea was no longer just an inconvenient curiosity.

  From the moment when Elizabeth I ascended to the throne in 1558 to the foundation of the Bank of England in 1694, a period of 136 years, the Mint had issued no more than £15 million in gold coinage, of which half was in guineas that appeared after 1663. During the 45 years from 1695 to 1740, the Mint produced £17 million gold coins. The story on silver is precisely the opposite: L20 million in the earlier period versus rl million in the latter.52

  Isaac Newton is the anti-hero of this chapter of our story. Quite aside from his scientific achievements, he deserves heroic status as the first civil servant in history bold enough to employ the laws of supply and demand to make an economic forecast that would determine public policy. He is the anti-hero, nevertheless, because he inaugurated a tradition that will haunt future chapters of this history: economic forecasts by policymakers that turn out to be wrong! Newton did a lot better predicting the future movement of an apple than of the price of gold.

  The real hero of this chapter, the guinea, came to a strange end. A direct descendant of Croesus's stater, Constantine's bezant, the ducat, the genoin, and the florin, the guinea remained the basic gold coin of England for another one hundred years after the events just described. In 1821, under George IV, the guinea came to an official demise when it was replaced by the sovereign, which was set equal to precisely 'Cl instead of the awkward 21 shillings of the guinea.

  The guinea lingered on not as a coin but as a denomination or offbeat unit of account. Prices quoted in guineas had snob appeal and served as reminders of a great past. Doctors on Harley Street quoted their fees in guineas, and fine jewelry and clothing were priced in the same fashion. But 21 shillings no longer made sense as a denomination when Britain joined the rest of the world and abandoned their historic shillings and pence for the metric system in 1969. The guinea finally vanished, remaining as a romantic memory or, on occasion, as a precious Christmas gift to children from doting grandparents who still owned a few of the beautiful coins stamped with the little elephant.

  Nevertheless, the process that the guinea began would stretch far into the future. From the moment that the markets established the supremacy of gold as the standard in 1717, the English never looked back. Over the next two hundred years, most of the rest of the world followed in their footsteps, though not always willingly. Silver never quite lost its charm and gold never quite performed its task without difficulty. The next chapter tells about one of the biggest bumps that the English encountered in trying to manage their currency with gold as the standard.

  n February 22, 1797, three frigates from the French navy sailed into the harbor of the tiny fishing village of Fishguard on the southwest coast of Wales and proceeded to land about twelve hundred armed soldiers. This little foray was confronted almost immediately by the local militia under the command of Lord Cawdor.* The French also caught sight of an approaching troop whose red cloaks and tall black hats convinced them that they were facing a contingent of the crack British unit, the Grenadier Guards-an even more serious danger.

  This fearsome band was nothing of the sort. The French soon discovered that it was nothing more than a gathering of Welsh women in traditional festival costumes.t The costumes did not inhibit the women from beating up the bewildered French soldiers. One of these women, Jemima Nicholas, was so adept at wielding her pitchfork that she was credited with the capture of fou
rteen French soldiers.' The French commander, an Irish-American general, was compelled to submit to an ignominious surrender.

  Rumors of an impending French invasion had been circulating for several months, with a series of reports from Paris referring to that danger. French warships had gathered at Brest at the end of 1796 and had headed off toward northern Ireland around Christmas, evidently hoping that the Irish would join in their invasion. On February 21, there was a false rumor of French ships off Beachy Head on the southeast coast, which provoked English warships to head out to sea from Portsmouth. The next day, the battle of Fishguard took place.

  Just what the French had in mind with this expedition remains obscure. Napoleon was off invading Italy, and Fishguard was about as far away from British power centers as anyone could get. The most reasonable explanation is that the French were making a low-cost but deliberate effort to create a panic in England. Seen from this viewpoint, their project was a smashing success.

  Like so many other events in this history, the foolish French effort had profound unintended consequences. Its ultimate impact reached far beyond the village of Fishguard or the nationwide panic that this comic opera episode ignited. The sequence of events that got under way as a result of Fishguard would lead in time to a great debate about gold, the causes of inflation, the international position of the pound sterling, and the proper function in all this of the Bank of England. The views of the highest political leaders and the most respected economists and bankers on these matters would command front-page attention. The debate would reach all the way back to the controversies between Locke and Lowndes at the time of the Great Recoinage about one hundred years earlier, and it would reverberate once again 125 years later in the wake of the terrible war of 1914-1918. It would guide British policy all the way up to the outbreak of World War II, when the farce of Fishguard had long since been forgotten.

  The excitement provoked by the French invasion launched a rush to withdraw gold from the banking system as frightened citizens stormed banking offices to cash in their paper money, almost all of which consisted of banknotes issued by the Bank of England as well as notes issued by smaller banks. While the Bank of England notes were the most widely accepted form of paper money in circulation-and traditionally referred to as Bank notes-the greatest fear was over what would happen to those small banks and the acceptability of their banknotes as means of payment in the event of an invasion.

  In contrast to the paper currency, gold was perceived as the ultimate money, indestructible in value and forever acceptable no matter who would be running the government, even if it were the French. The very idea that the Bank's gold reserve was rapidly diminishing therefore served as a self-fulfilling prophecy as people dashed to the banks to convert the paper notes into gold while there was still some gold left to withdraw.

  On Saturday, the 18th of February, even before the incident at Fishguard, fears of a French invasion had provoked a run on the banks in Newcastle (some 350 miles from Fishguard), forcing the local banks to shut their windows on the 20th. The panic soon spread to London and other major centers. The withdrawals were draining the Bank of England's gold stock at the rate of C100,000 a day, out of a gold reserve that had already shrunk under wartime conditions from f7 million at the end of 1794 to C5 million at the end of 1795 and then to only about _f2 million at the end of 1796.2

  Word of the "invasion" at Fishguard reached London on the morning of Saturday the 25th, three days after the fact, forcing the management of the Bank to face the unprecedented and unpleasant prospect of refusing to redeem Bank notes in gold. The Directors informed Prime Minister Pitt, who sent an urgent message to King George III at Windsor on Saturday evening to join a council to be held at the Bank on Sunday. In addition to the King, the Sunday meeting included Pitt, the Lord Chancellor, the Governor and Deputy Governor of the Bank, and two of the Directors. At the conclusion of the meeting, the government issued an Order-in-Council whose most important passage read as follows:

  It is indispensably necessary for the public service that the Directors of the Bank of England should forbear issuing any cash [i.e., gold] in payment until the sense of the Parliament can be taken on that subject and the proper measures adopted thereupon for maintaining the means of circulation.3

  On March 9, the House of Commons transformed the Order-inCouncil into a full-fledged act, the so-called Restriction Bill, which indemnified the Bank against the legal consequences of refusing to pay out gold in exchange for the Bank notes. The bill also made it official that all payments in Bank notes were to be "deemed payments in cash."

  A public relations campaign swung into action at once to reassure the public and to prevent the gold crisis from turning into an even more intense panic. On Monday, February 27, in words that sounded like the exhortations of the darkest days of the Battle of Britain in 1940, the Times of London published a lead editorial invoking the spirit of the embattled English at the time of the Spanish Armada, when the danger to life and property was much greater. At noon that day, the leading bankers and merchants of London met at the Mansion House, home of the Lord Mayor, where they passed a unanimous resolution declaring that it was their intention to receive without hesitation notes of the Bank up to any sum of money that would be owed to them and that they would make their own payments in Bank notes as well. This resolution, which received four thousand additional signatures, was published in newspapers throughout the country. The Directors of the Bank then issued a notice declaring that the Bank was in a "most affluent and prosperous situation, and such as to preclude every doubt as to the security of its notes," with assets (primarily claims on borrowers) some £4 million in excess of liabilities, not even counting the debt owed by the government of close to £12 million.4 This reassurance about the financial condition of the Bank was critically important, as many smaller banks had either failed or suffered a dangerous deterioration in their condition during the excitement provoked by the original declaration of war against the French Revolution in 1793.5

  Despite the soothing words about the Bank, the Order-in-Council of February 26 and the Restriction Bill that followed were shockers. The crisis was unique up to that point in history. Governments had often devalued and debased their coinages in other wars, but then only coins were involved. The Chinese had made a mess with their paper currency, but then no coins were involved. This was the first time that the markets had attacked a paper currency freely convertible into gold coins or bullion, a right that had existed for over a century. The Bank of England itself had been established as the paradigm of financial soundness and responsibility. The Bank's notes had been "as good as gold." Indeed, Bank of England currency, decorated with the corporation's seal and engraved with Britannia seated on a bank of money, was deemed more acceptable than obligations of the government itself.

  Suddenly, all that changed. With the vaults almost bare of gold, the Bank notes were now no more than pieces of paper. The claims on borrowers may have exceeded the Bank's liabilities, but those claims were far from the same thing as gold; even if the borrowers repaid all their loans, the Bank would still have only Bank notes on hand to pay out.

  The impact of this unexpected rupture can be gathered from the memoirs of a Scotch banker, Sir William Forbes, who recalled the experience in his Memoirs of a Banking House, published in 1803. Forbes describes how he felt on the morning of March 1 when the first word of "this interesting event" reached Edinburgh:

  Now it was that I certainly did think the nation was ruined beyond redemption, when so novel and alarming a circumstance had taken place at the Bank of England, which had ever been considered the bulwark of public and private credit.... All ceremony or etiquette... was now out of the question when we had to think of what was to be done for our joint preservation on such an emergency.... The instant this resolution of paying no more specie was known in the street, a scene of confusion and uproar took place of which it is utterly impossible for those who did not witness it to form an idea. Our counting
house ... was instantly crowded to the door with people clamorously demanding payment in gold of their interest-receipts ... they were mostly of the most ignorant classes ... all bawling out at once for change.... Both gold and silver specie was hoarded up and instantly disappeared.`'

  Nevertheless, the way the English dealt with these matters, once the crisis had passed, was as extraordinary as the decisiveness of the authorities at the moment of a crisis that none of them had ever faced before. As Forbes continued his account, "It was a matter of agreeable surprise to see in how short a time after the suspension of paying in specie, the run on us ceased [and] how quietly the country submitted ... to transact all business by bank notes for which issuers give no specie as formerly."

  There was no argument against the principle that gold must continue to be the central foundation of the monetary system, and that some day redemption in specie would be restored. The language of the long sequence of government orders that was to follow gives every indication that most people believed that the arrangements were temporary, with normal conditions soon to be restored. The entire objective was to reach a point where notes could once again be converted into gold on demand. The embargo would endure for 24 years, until 1821, a length of time that even the most pessimistic observers never anticipated. But widespread confidence in an ultimately happy ending to the tragedy meant that acceptability of the Bank notes was at no point brought into question anywhere. The notes continued to function as though nothing had happened to the gold reserves. When Winston Churchill observed during World War II that "England loses every battle but the last one," he was reflecting a spirit that had long been typical of English perceptions of themselves and their state.